German Foreign Investment Control goes Future Technology and Beyond

2020 has been a record year in foreign investment control.  There have been three major reforms in Germany and a record number of cases were filed with the competent Ministry of Economics and Energy (“BMWi”), not to mention one leaked prohibition decision.

Despite these notable developments, yet another significant reform is in the pipeline (the “FI Reform”), a draft of which was circulated to certain stakeholders at the end of last week. The FI Reform marks another important step in German foreign investment control and may serve as welcome guidance for other foreign investment regulators across Europe by tackling the extremely broad terms of the Regulation (EU) 2019/452 (“FI Screening Regulation”) as it applies to sensitive sectors. 

The amendments envisaged by the FI Reform include, in particular:

(a) expansion of sectors under the so-called “cross-sector review regime” addressing non-EU/non-EFTA investors by adding a further sixteen to the currently eleven sectors triggering a mandatory filing requirement;

(b) expansion of sectors trigging a mandatory notification requirement under the so-called “sector-specific review regime” addressing non-German investors in the wider defence and export control space;

(c) expansion of reporting requirements; and 

(d) closing of certain gaps in the current regime to avoid any strategy of circumvention of foreign investment control (including joint acquisitions by several investors).

As a result of this reform, which is currently being consulted upon, and may be adopted by the government as early as in March 2021, the number of filings is expected to double relative to 2020, which was already a record year, and exceed 300 cases p.a. This will put an additional burden both on companies going through such review process and on the BMWi with a significant additional workload. 

1 Background

Germany already has an active and well-established foreign investment control regime which is – depending on the activities of the German target company, the identity of the foreign investor and the percentage of voting rights acquired – either mandatory or voluntary. At European level, Germany was – together with France and Italy – the driving force behind a more harmonised and consistent approach to foreign investment control.

In brief, the current German foreign investment control regime consists of three pillars:

• A mandatory “sector-specific review process” for all non-German investors acquiring 10% or more of the voting rights in a German target carrying out certain defence and IT security related activities in Germany;
• A mandatory “cross-sector review process” for non-EU/non-EFTA investors (notably now also including the UK) acquiring 10% or more of the voting rights in a German target active in certain sensitive sectors; and
• A voluntary “cross-sector review process” for all non-EU/non-EFTA investors (again now including the UK) acquiring 25% or more of voting rights in a German target active in any other sector with the possibility for the BMWi to initiate an ex officio review within five years of signing if a transaction has not been voluntarily notified.

Over the last three years, the German foreign investment rules have been substantially strengthened by lowering the applicable acquisition thresholds to 10% of voting rights for certain sectors and repeatedly extending the scope of sectors to which a mandatory filing requirement applies. In addition, gun jumping (in case of mandatory filings) is now subject to criminal or administrative sanctions and the substantive test has been lowered to include a clear prognosis element. Finally, an EU-wide cooperation mechanism between EU Member States and the European Commission has been in force since October 2020, involving a coordinated exchange of information on ongoing foreign investment cases between 16 EU foreign investment regulators  and the EU Commission.

2 Overview of Proposed Changes

The FI Reform aims to further strengthen the foreign investment rules by extending the scope of the two mandatory regimes. While this expansion is mainly driven by the FI Screening Regulation, it is noteworthy that the draft bill is the first to tackle the very broad terms of the Regulation, implementing certain limits (although the boundaries are not always entirely clear). On the other hand, in certain instances, the draft bill goes further and provides details on which other activities are also seen as more sensitive from a foreign investment perspective. The practical implication of such categorisation is not only that a foreign investment filing is mandatorily required for relevant acquisitions but also that an in-depth review of such transaction is significantly more likely.

2.1 Cross-sector review regime

Most relevant for non-EU / non-EFTA investors are the additional sectors which will now also trigger a mandatory notification requirement.

2.1.1 New sensitive sectors: Critical technology, critical inputs and sensitive information

The FI Reform focuses mainly on critical technologies as defined in the FI Screening Regulation, covering artificial intelligence, robotics, semiconductors, cyber security, aerospace, as well as quantum and nuclear technology. Beyond critical technologies, the draft bill covers certain further specified dual use technologies, critical raw materials and food security, as well as certain elements of sensitive information. Notably, generic terms of the FI Screening Regulation are – to the extent possible – concretised, either by reference to special German or EU laws such as the Satellite Data Security Act, the Regulation (EC) No 1008/2008 on common rules for the operation of air transport services, certain item numbers of the Regulation 428/2009 (the Dual Use Regulation), the European Commission’s critical raw materials list, the Patent Act and Utility Model Act, or by further delineation of the relevant terms directly in the German foreign investment rules.

This approach is generally very welcome as it results in a much clearer delineation of relevant activities compared to the EU rules, which many other countries simply “copy pasted” into their national laws.

By way of example, the term “artificial intelligence” is limited to abusive fields of application of artificial intelligence technology that are in conflict with fundamental values and rights, in particular the protection of privacy and informational self-determination.

For a full list of relevant sectors, see Section 2.1.4.

2.1.2 New sensitive sectors: Going beyond the literal reading of the FI Screening Regulation

Going beyond the wording of the FI Screening Regulation, the FI Reform will also cover automated driving or flying, optoelectronics, operation of air carriers, and additive manufacturing. The German government considers these activities, together with the critical technologies taken from the FI Screening Regulation, to cover all key technologies which are of fundamental importance for the future and resilience of the German economy.

2.1.3 No new sensitive sectors: biotechnology, nanotechnology and others

It is rare these days in the foreign investment landscape that regulators limit themselves. Hence, it is remarkable that the draft bill specifically excludes certain sectors from the mandatory regime, despite being listed in the FI Screening Regulation: biotechnology, nanotechnology and energy storage. Certainly, to some extent these sectors are included in other definitions (e.g. healthcare) but to the extent these sectors go beyond, Germany is limiting its scope of jurisdiction to voluntary filings or ex officio investigations. Considering, in particular, the breadth of the terms bio- and nanotechnology, this is a very welcome message.

Further, personal data in general was explicitly left out in the draft bill as almost each company holds personal data and since an inclusion would have expanded the scope of the regime indefinitely.

The government has also not followed the suggested approach in the FI Screening Regulation to generally refer to the Dual Use Regulation. In the government’s view, a general reference would be disproportionate. However, the government acknowledges that being listed in the Dual Use Regulation may be an important indicator of security relevance.

Consequently, this limitation of the law does not mean that foreign investors are entirely off the hook and a case by case analysis may still result in voluntary filing being recommended to increase transaction certainty.

2.1.4 New sensitive sectors - Summary

A full list of relevant activities which may come into scope of the regime is:

Note: In many instances, not all activities in these sectors will be in scope of the mandatory regime but considering the complexity of relevant definitions, we only include this abbreviated list in this client alert. In case of specific questions, please get in touch.

2.2 Sector-specific regime

In the context of the “sector specific review process” which is mainly aimed at the military sector, the provisions limiting the scope of application to a selected number of military products will be replaced by substantially more far-reaching provisions.

Further, the reform will incorporate the modification of military products, as well as their development and manufacture.

2.2.1 Extension to the full German Export List

The newly introduced first case group of the sector specific regime will include all military equipment within the meaning of Part I Section A of the German Export List. Until now, only very few list items were included.

2.2.2 Development, manufacture, modification or possession of defence technology

A newly introduced second case group covers investments in companies that develop, manufacture, modify or have in their possession certain defence technology to which secret patents or certain secret utility models relate.

These patents and utility models are classified as state secrets based on an examination by the competent authorities. For reasons of secrecy protection, such companies must ensure that the patents and technologies are not published and that no outflow of know-how to foreign countries occurs.

For investors in companies with such patents and utility models, it will be crucial to determine whether they come from a country with which the German Federal Republic has an agreement on the protection of state secrets.

2.2.3 Defence-important facilities

While the third case group of the sector specific regime (products with IT security functions for processing of classified government information) remains more or less unchanged, the draft bill includes a fourth category of “defence-important” facilities in the meaning of the Security Clearance Act, i.e. facilities outside the Federal Ministry of Defence’s responsibility which serve to establish or maintain defence readiness and the impairment of which is due to the lack of short-term substitutability a substantial threat to the functional capability, in particular the equipment, command and support of the Federal Armed Forces and allied armed forces as well as of civil defence.

2.3 Further Amendments and Clarifications

Besides a number of rather legalistic adjustments, the FI Reform will clarify the applicable thresholds for the mandatory regimes: In particular, atypical acquisitions of control below the acquisition of 10% of voting right are covered by the German foreign investment regime. While this is in line with the BMWi’s practice to date, the clarification in the draft bill provides welcome guidance to investors. The acquisition of control in terms of the draft bill may result from agreements between investors or shareholders providing strategic influence irrespective the low shareholding. The government refers by way of example to board seats for or executive functions of the investor, veto rights on strategic decision and substantial information rights.

However, the acquisition of atypical control does not trigger a mandatory notification requirement, but the BMWi can initiate an ex officio investigation. This concept is well known from merger control regimes and a comparable rule also applies under the US CFIUS regime.

Further, the government clarifies that the acquisition of additional shareholdings will trigger a new notification requirement even if the thresholds were already met prior to the transaction. As a result, follow-on acquisitions, even of tiny shareholdings, trigger a mandatory notification requirement. While this is a mere clarification of BMWi’s practice, it is unfortunate that no de minimis threshold has been proposed. Neither have specific rules relating to public takeover situations, this being an area for which an established and well-functioning legal framework exists in merger control, which may also serve as a guidance in foreign investment control.

The FI Reform also unveils a requirement for voting rights agreement where several investors acquire voting rights in parallel together exceeding the 10% threshold. Several investors may be considered together where no voting rights agreement is in place. Investors may be considered jointly in future where other circumstances lead to the conclusion that voting rights will be exercised jointly. This will be presumed particularly where each of the investors are from the same country and where each of the investors is controlled by the State (a rule which certainly has a certain China focus).

3 Key implications for investors

The new reform will have far-reaching implications for foreign investment in Germany. The number of transactions within the scope of the mandatory notification requirement will likely double – if not more. Companies engaged in M&A in many more sectors may have to go through a formal approval process, which may add considerable time to the transaction timetable.

Considering the severe sanctions under German foreign investment rules (including up to five years of imprisonment in case of intentional breach) it is welcome that the draft bill provides more legal certainty than the undefined terms in the FI Screening Regulation. Yet, it is unfortunate that certain definitions still remain extremely broad (e.g. in the healthcare sector) and that the draft bill misses out on addressing additional shareholding increases (at least in instances in which an earlier investment was notified and cleared) as well as public takeover situations.

While it may take another two months until the reform comes into force, companies engaged in transactions in newly added sensitive sectors should already be considering the scope of the rules carefully, since the BMWi may scrutinise transactions in these sectors under its current ex officio investigation powers.

For successful and smooth investments in German target companies it will be even more essential for foreign investors:

• to conduct a thorough upfront filing requirement (which will become more onerous under the new rules) and risk analysis under German foreign investment rules;
• to properly prepare filings, in particular where they relate to sensitive sectors, and to remain open and transparent in proceedings;
• to carefully assess and proactively disclose the relations and agreements between co-investors;
• to care for a potentially longer review timetable and adequate risk allocation in the transaction agreements; and
• to factor in the wider picture, in particular at EU level since, the BMWi will likely change its practice and – going forward – notify all foreign investment applications to the EU coordination mechanism (as opposed to only Phase II).